January 2008, a young artist called Michelangelo signed a contract with a charity named Art Angels, which supports young artists to do large projects. The agreement requires Michelangelo to paint a night sky with stars, and a day sky with cherubs and roses on the inside of the enormous dome of the building where Art Angels is housed, and stipulates a 36 month contract with a total sales value of £300,000. Michelangelo expects to spend 25 per cent of this amount on painting materials and the rent of scaffolding, spread out evenly over the 36 months. As he is rather short of cash, he receives an advance of £25,000 when signing the contract. He will receive another £25,000 at the end of the year if he has completed one third of the dome, then £50,000 at the end of the second year if he has completed two thirds of the dome, and the remaining £200,000 at the end of the third year if he has completed painting the whole dome.
(a) Calculate Michelangelo's profit or loss at the end of each year on a cash basis and on an accruals basis, assuming that Michelangelo's expectations regarding his expenses were correct and that the expenses had been paid for in cash, and assuming that he recognises revenues as he earns them in accordance with the contract.
(b) How does Michelangelo account for the difference between cash receipts and revenues in his accruals-based financial statements at the end of each year?
(c) It may seem unfair that Michelangelo will receive most of the money for the contract at the end of the three years. Explain, in no more than 200 words, what reasons Art Angels may have had to stipulate these conditions.
(d) Explain, using accounting concepts and principles, why Michelangelo should not recognise the £300,000 as revenue:
(i) at the date of signing the contract
(ii) at the end of the three year period.